I am a Professor of Economics at Texas Christian University, where I have worked since 1987. My areas of specialty are international economics (particularly exchange rates), macroeconomics, history of economics, and contemporary schools of thought. During my time in Fort Worth, I have served as department chair, Executive Director of the International Confederation of Associations for Pluralism in Economics, a member of the board of directors of the Association for Evolutionary Economics, and a member of the editorial boards of the American Review of Political Economy, the Critique of Political Economy, the Encyclopedia of Political Economy, the Journal of Economics Issues, and the Social Science Journal. My research consists of over thirty refereed publications, two edited volumes, and one book (with another in process). I have also been lucky enough to win a couple of teaching awards.
In terms of my approach to this blog, I am a firm believer that economics can and must be made understandable to the general public, but that our discipline has done a very poor job in this regard. This is particularly true of macro issues, where people quite naturally assume that their personal experiences are analogous to those at the national scale. Very often, this is not the case, with the result that politicians and voters (and some economists) press for policies whose effects are quite the opposite of what was intended. That this is problematic has never been more evident than today. I also try to steer as clear of politics as possible. I want to explain how things work, not what you should believe.
I have been married to my wife, Melanie, for over twenty-five years, and we have twin daughters (who have just started college) and a dog named Rommel (who has not). My favorite pastimes are online computer gaming and reading about WWII history.

What Actually Causes Inflation (and who gains from it)

Another means by which inflation can take place is a rise in demand relative to supply. Say there is an increase in the demand for housing during an economic expansion. Bottlenecks may arise in certain building supplies like lumber. Contractors bid up these prices in an attempt to secure the materials they need; these price increases then ripple through the economy. Firms and consumers again desire a larger money supply to be able to operate, which the Fed presumably accommodates. The producers of lumber and bricks may also experience a rise in their incomes as part of this process–and why shouldn’t they? This is how a market system is supposed to work. Those selling goods and services in highest demand should see their profits and wages rise, even though by definition this will almost certainly cause inflation. This attracts others to sell these same goods and services, while some consumers go in search of substitutes. This is the greatest strength of a market system, it’s flexibility in the face of unanticipated changes.

Causes of Inflation: Asset Market Boom

Third and very relevant today, inflation can be injected from the asset market. The connection between the prices of goods and services and those of financial assets is tenuous. Sometimes there is practically none at all. Witness the 1990s, with a massive increase in stock prices but very little movement in the consumer price index. However, lines of causation can exist, particularly though commodities futures. I have already written about this at length in the context of gas prices:

The gist of the above is this. When speculative money bids up the price of a commodity future, this creates an incentive for those actually selling the commodity to withhold supply today in favor of the future (when prices will presumably be higher). The rising spot price then convinces the speculator that her bet had been correct, and she increases her position. This may drive futures prices even higher, and so on. Thus, a goods price is driven up by the price of a financial asset. The winners here are 1) those whose portfolios include those assets (of course, they can only realize their gain by selling) and 2)the producers of the commodities in question. Those producers often bear the brunt of the blame for these inflations, but they are not actually the source. As usual with inflation, it leads to a rise in the money supply as agents take out loans and sell government securities. The way to stop this inflation is not via blocking monetary growth, however, but to control the link between the asset market and the commodity price.

Causes of Inflation: Supply Shock

Last is a supply shock. If a storm rages through the Gulf of Mexico, taking out oil derricks and refineries along the way, this may well raise the price of oil and gas. As it should, for this creates incentives to build more derricks and refineries and for consumers to find alternate energy sources. Again, this is what capitalism is supposed to do. In terms of who wins with this sort of inflation, it’s obviously more complex since it depends on whose derricks were destroyed and who gets to build new ones. In any event, this, too, can lead to a rise in the money supply and there is no logical reason for the Fed to block this.

Conclusions

This is not an all inclusive list, but I would think that it covers the vast majority of what we have experienced since the end of WWII (today, we are most threatened by the link between financial markets and commodities). The bottom line is that there are a number of processes that can create inflation, none of which starts with, “the money supply increases.” Someone make a conscious decision to raise a price or wage, and they must be able to make this stick. Because every higher price you pay means someone is getting more income, inflation causes a redistribution of income. Sometimes it does so in a manner that we would endorse and sometimes not. But in any event, it causes a rise in the demand for money that the Fed will almost certainly accommodate–and rightfully so, for refusing to do so almost always serves to punish those already in the weakest position.

I’m afraid this more realistic perspective does not offer a nice, simple rule as in the money growth ==> inflation camp. That said, neither do they since that’s not how the world really works! In reality, monetary policy does not cause inflation, and it is not well placed to stop it. What it does do is very strongly and directly affect interest rates. But prices are determined elsewhere in the system.

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Thank you for an excellent piece both in it’s own right and as companion piece to your previous blog on this topic. Since your first piece, the futures market has changed more than a bit. With the increase in margin charges all of a sudden futures prices have dropped substantially. This can only mean that the buyers had borrowed money to finance their purchases far more than the sellers had so when the lenders saw the increase in the margin and called in the loans, there were more buyers caught short than sellers and prices fell. In the case oil, it was a big enough drop force down prices of gasoline at the pump. Clearly there was more than a bit of speculation occurring.

If the product is potatoes, even with high unemployment, people starve without potatoes so they are eating all they are able. y therefore, cannot go up because there is simply no demand. The price has to go up.

What!? If the potato seller doesn’t see demand, he’ll try to cut on production and maybe cut prices to the bare minimum above break even. If he sees demand, then he’ll try to increase production to meet demand and will only raise prices when he cannot meet the demand any longer. I am not sure you yourself understand what you’re saying here. That prices for potatoes will go up when there is no demand for potatoes!?

[...] What Actually Causes Inflation (and who gains from it) I made a post two weeks ago in which I explained that the popular view of inflation (wherein it is caused by money growth) depends critically on assumptions that do not hold in the real world. Money comes into existence when someone adds it to her portfolio of assets. This occurs either when she borrows money (which creates new cash from reserves) or sells securities to the Federal Reserve … Read more on Forbes [...]

[...] What Actually Causes Inflation (and who gains from it) I made a post two weeks ago in which I explained that the popular view of inflation (wherein it is caused by money growth) depends critically on assumptions that do not hold in the real world. Money comes into existence when someone adds it to her portfolio of assets. This [...] Read more on Forbes [...]

“Another means by which inflation can take place is a rise in demand relative to supply”. Mr. Harvey, I think that you are missing something here. People have a great many unfulfilled desires. When they are all of a sudden given more money for whatever reason, they get a chance to fulfill those desires. They buy. Those purchases constitute a demand. With greater demand (relative to supply as you have noted) companies can raise prices, and they do, simply because they wish to make more money which they could not do when those people had no money. Therefore you see, money does, in fact, cause inflation.

With greater demand (relative to supply as you have noted) companies can raise prices, and they do, simply because they wish to make more money which they could not do when those people had no money

This is wrong. Companies don’t raise money first but increase supply. This is because raising prices risks losing market share (see under “competition”). Increasing market share beats making money off existing market share any time. Besides, there are costs to raising prices (reprinting catalogs etc.) No, the firms raise prices only when they cannot meet the increased demand with increased supply. Which was Prof. Harvey’s point to begin with.

This seems unlikely to me or at least depends on the good in question. A car cannot just be created and shipped across the country at a moment’s notice if a dealership is dealing with intense demand. If two people want the same Volkswagen, the dealership doesn’t keep the price at X and flip a coin to see who gets it. The initial mechanism will be to raise prices, rather, because real-world supply of goods is not immediate.

Also, I own a company and I would much rather make money from my existing market share paying a higher price than make the same amount of money by expanded market share paying a lower price. If I can make a million dollars from one of a good why would I prefer to go through the trouble of instead making a million of a good for one dollar? I believe it is competition from similar producers that keeps prices stable. In an atmosphere of high demand for your product, however, this becomes immaterial as consumers have decided that your product is worth the higher price. This seems like a fairly common-sensical notion, but maybe I am mistaken. Where, if I may ask, did you come by your opposing assumption that companies prefer high volume to high prices?

I believe this is parallel to Milton Friedman’s helicopter explanation. Your key statements are “When they are all of a sudden given more money for whatever reason, they get a chance to fulfill those desires. They buy…With greater demand companies can raise prices…”

You are absolutely correct that if money just magically appears in people’s hands they will spend it and it will ultimately cause inflation. That’s actually the argument that Milton Friedman made a long time ago (he used a helicopter dropping money as the mechanism by which this money appeared, fyi). Yet, this is a key difference, I think, between the Post Keynesian economics Dr. Harvey is describing and Monetarist/Neoclassical economics; while it is okay to base Monetarist theories on inexplicable appearances of money, Post Keynesian based theories have the constraint of reality.

You see, in reality, money doesn’t suddenly appear in your hands. It must be obtained through conscious effort, such as the selling of one’s ownings of Treasury Bills. But people don’t just randomly cash out their assets – they have to have a reason. In the Post Keynesian vein, that reason is to afford the rising prices (inflation) in the real economy. Thus in Post Keynesian theory, inflation CAUSES a growth in the money supply, whereas in Monetarist theory growth in the money supply CAUSES inflation. The Post Keynesians have in their corner a real-world explanation of the cause-effect relationship rather than a hypothetical helicopter dropping free cash.

Prof Harvey. Isn’t there an additional source of inflation coming from wages growth, which in turn is a result of our psychological propensity to expect to be paid more every year even without any increase in our productivity? On another blog this has been posted: http://heteconomist.com/?p=2267&cpage=1#comment-10639 and in the following discussion the question raised:Shouldn’t we have dy/dx = 0 or dy/dx < 0 whenever there is an output gap? Seems to me that wages growth can explain this phenomenon, but I am not certain. Thanks in advance!

[...] for inflation to be said to exist. So where does inflation come from? Professor John T. Harvey in an excellent summary gives four main sources: (1) Market power: This is monopoly plain and simple. I stole all the [...]

Your column left out some important facts about oil prices. The Texas Railroad Commission Commission controlled the world balance of supply and demand until 1971, when US oil production peaked and US imports skyrocked. So political will by OPEC became possible and effective only when they controlled the marginal supply. They lost that control by the early 1980s due to conservation and increased oil production from Alaska, the North Sea, and other places, so oil prices plummeted. OPEC’s market share has recovered to 40%, and if we are not smart enough to increase our domestic liquid fuel supplies, OPEC will get us again and again over the coming decades.

This is taken from your article “Money Growth Does Not Cause Inflation”:

MV = Py 400 x 5 > 10 x 100

there is no reason that this could not lead to the rise in y shown below as those spending their “excess money balances” actually cause entrepreneurs to raise output to meet the new demand:

MV = Py 400 x 5 = 10 x 200

This statement is very questionable. If the product is potatoes, even with high unemployment, people starve without potatoes so they are eating all they are able. y therefore, cannot go up because there is simply no demand. The price has to go up. Other things that people buy are items made in say, China, but if they buy those things that will not put people to work in the U.S. Your ideas are over-simplified.

The most costly things that people buy are cars and houses. There is a long-term over-supply of both these items, so what exactly are you going to raise demand on? I am afraid that you are trying to solve a long-term problem with a short-term answer. And you have to solve it, and solve it, and solve it indefinitely. And because goods are made so cheaply in other parts of the world, in order to trade with them you will have to give them money that they may not accept, and that has already started to happen. the drop in the U.S. dollar tells us that U.S. credit is becoming N/G. Listen to Moody! Sorry, but you will not fix anything by printing more money; you are just kicking the can down the road.

Short-term solutions to long-term problems will just not work. J. M. Keynes assumed that all debts were paid to begin with so in a depression a short-term solution was O.K. But that is not the case now. Get real!

How about Hyperinflation? Would it be correct to say that your primary causes of price increases listed above function when an economy is in “normal” mode but hyperinflation occurs when the economy goes way beyond normal and massive “printing” of money leads to massive price hikes that end in an exponential and rapid financial insanity

So we got out of the 1970s recession by printing more money? Nonsense – in fact, the opposite is true. The Fed raised interest rates, crushing inflation. This, using the economic principles you laid out, lowered demand and the monetary supply. But how could lowering demand actually bring us out of a recession? Because it brought down demand of oil, which in turn brought down oil prices, which brought down prices in general. See the point?

Although your articles are very thought provoking and otherwise interesting, they fail to pass the logic test. Sorry!

It would seem that the fundamental cause of at least some inflation in an economy is the profit derived from economic transactions and the accumulation of wealth that occurs as a result of any unspent profits. This wealth in all liklihood creates a wealth price spiral, similar to the oft mentioned wage price spiral. The two are essentially the same from the perspective of the goods being pursued.

Corporate profits range from 5 to 10% of GDP and average perhaps 6.5% over the last 50 years. This amount is not insignificant, particularly when one considers the iterative nature of these investments and the ever increasing demand for returns. Corporate profits in the past few years have been in the range of 10% of GDP and surely have some impact on prices, if for no other reason than the speculation that might occur as a result of seeking returns on that capital.

yep, this is almost absolutely perfect. but you are not considering what many people is talking about, for example, in italy, which is where i’m from. here, many want DIRECT MONETARY FINANCING of public deficits. that is, printing money because some politician needs it for whatever he wants to do. and well, this causes inflation. who wins? obviously, the politician and those who vote for him. simple as that!

” When speculative money bids up the price of a commodity future, this creates an incentive for those actually selling the commodity to withhold supply today in favor of the future (when prices will presumably be higher). ”

This doesn’t look reasonable unless the commodity is scarce, in which case this is an example of Demand Pull Inflation. If the commodity is not scarce, the sellers will prefer to supply both demand today and the speculative contracts tomorrow that are at higher prices.

Even when the commodity is slightly scarce, the seller requires a substantial premium for future contracts, not only due to risk and uncertainty, but also because the seller does not want to invest in warehouses and hold onto supply that does not make money.

While the things you mentioned definitely cause prices to inflate, I don’t agree that they are the main causes. If they were, inflation wouldn’t be happening at such a steady predictable rate. Besides, as technology gets better, we’re more likely to see a greater supply (relative to demand) of basic necessities. Not the opposite.

Money growth, by definition, causes inflation, because the total amount of money in the economy, per capita, increases. The price of every product therefore increases proportionally, in the long term.

You first define inflation as a rise in the _average_ prices of goods and services. Then you go on to list several ways that _individual_ asset classes can be increased in price: by demand pull, supply shock, and speculation. These phenomenon do not inflate all goods/services at the same time, and therefore these examples are really irrelevant to what causes inflation in the entire economy. The only way that a sustained inflation will occur is if there is an increase in the money supply. This has occurred numerous times throughout history, whether through the dilution of silver content in coins or the more modern mechanism of printing more promissory notes / dollars.

I agree with almost everything said here about the many causes of inflation, for some times inflation does not come from central banks decision, but instead from real people decisions, however, in most cases monetary policies are the main cause for inflation , I just saw a few videos about it (this ones: https://www.youtube.com/watch?v=qv0bJzCdcLU and this https://www.youtube.com/watch?v=ccV7G3JEB2A ) and the consensus is that currency’s excessive supply causes the currency to devalue against others and that causes inflation. so the Monetary policies are responsible for inflation. Nobody really wins with it.